Binomial Lattice Model: Application on Carbon Credits Market

Abstract

It is known from literature that many models of financial mathematics are based on the assumption of normality returns. Thus, the normal distribution is not a single model to fit the log-return distributions. It is very important to consider an alternative class of probability distributions which is able to model the effects caused by asymmetric data. This paper is a survey about the log-returns of Certified Emission Reductions (CERs), carbon credits generated by projects of the Clean Development Mechanism. The contracts are priced through the binomial lattice model proposed by Cox. Therefore, the model is discussed in order to represent the random parameter behaviors of CERs contracts and evaluate the benefits and exposure to them.